Like many trust concepts, a fixed trust does not have a single meaning. It is most useful to consider fixed trusts along a continuum.
At one end, you have a trust where the trustee holds one asset for one beneficiary, and the beneficiary can call for the asset to be distributed to them at any time. Likewise, if the trustee receives any income referable to the trust asset, it must immediately pass it on to the beneficiary.
At the other end, you have a trust where a set number of beneficiaries have a defined proportional interest in the trust assets, represented by the number of units they hold. Think of a unit trust holding a mix of shares and property. This may fit some criteria of a fixed trust because:
- the beneficiary knows what their proportional entitlement is;
- they know that, if the trustee distributes income, they will be entitled to a set percentage of it; and
- they also know that if a trust asset is distributed, or sold and the proceeds distributed, they will have a fixed proportional entitlement to that distribution.
But a unit trust may be a long way along the continuum if the trustee can:
- decide whether or not to make distributions;
- decide to sell any trust asset and keep the proceeds pending a later distribution;
- admit other unitholders to the trust, changing a unitholder's proportional interest; or
- issue those units at a value which dilutes the proportion and value of existing unitholders' units.
When is the issue of a fixed trust relevant?
This article primarily explores the concept of fixed trusts in relation to the Income Tax Assessment Act 1936 (Cth) (ITAA36).
However the concept of a fixed trust appears elsewhere, in respect of which different definitions apply, such as:
- whether a trust is a fixed trust for the purposes of the Land Tax Management Act 1956 (NSW); or
- whether a trust is a fixed trust for the purposes of the principal place of residence land tax exemption in Victoria under the Land Tax Act 2005 (Vic).
What the law says
Under the law, the Commissioner has a discretion to treat a beneficiary's entitlement as fixed.
In isolation, the provision does not provide a great deal of certainty regarding the factors that will inform the Commissioner's exercise of the discretion. With the release of the draft PCG, we now have a better sense of what the Commissioner thinks the provisions mean in practice and crucially, when an interest might be regarded as not being capable of vesting or when it might be defeated.
The circumstances where the ATO is likely to exercise the discretion to determine a trust entitlement is fixed
The ATO's view is that it is difficult in practice for many trusts to satisfy the fixed trust definition, unless the Commissioner exercises the discretion.
So even though a trust may not readily be regarded as a fixed trust, the Commissioner's discretion allows for a broader category of trusts to be nonetheless regarded as fixed. The draft PCG explains the factors that the Commissioner thinks are relevant to exercising the discretion, including:
- the circumstances in which the interest is capable of not vesting or being defeated (which are circumstances that lend weight to a conclusion that the trust is not fixed)
- the number of circumstances when a beneficiary's interest may be defeated — an aggregation of circumstances might result in the Commissioner deciding against exercising the discretion. For instance, if a trustee has several powers available that could diminish a beneficiary's interest, this would lend itself to the Commissioner not exercising the discretion.
- the significance of those circumstances — for instance, units in a trust listed on the official list of an approved stock exchange is a factor of significance that would weigh in favour of the discretion being exercised. This is because the various control elements of the Corporations Act 2001 and the ASX Listing Rules affect the trustee's exercise of its powers. The Commissioner is likely to exercise the discretion in these circumstances.
- whether any preconditions affect those circumstances having regard to:
- the person capable of altering the beneficiary's interest;
- the nature of the person's relationship to the beneficiary; and
- limitations on the person's capability to alter the beneficiary's interest.
A precondition requiring the trustee to obtain unitholder consent to redeem units is expressed in the draft PCG as having a neutral impact. However, a trustee with an unlimited power to redeem units will unfavourably impact the Commissioner's exercise of the discretion.
- the likelihood of the interest not vesting or being defeated
- If a power to defeat the interest is available, the Commissioner may consider how often, if at all, the relevant trustee or equivalent person has exercised the power over a relevant period.
- the nature of the trust
- The trust's basic legal characteristics.
- The trust's economic function — both actual and intended.
The ability to adversely affect a beneficiary's interests — the draft PCG sets out instances where this ability might be limited, such
- fiduciary responsibility restrictions;
- contractual restrictions;
- industry regulation restrictions;
- product Disclosure Statement commitments; or
- restrictions in the trust deed.
- other factors
- The Commissioner will consider other relevant factors including the purpose for which the discretion is being considered.
- For instance, it is the ATO's position that it is relevant for the Commissioner to consider whether the exercise of the discretion would allow a person to obtain a tax benefit from the trust loss provisions when the person did not in fact bear the economic loss incurred by the trust.
The draft PCG includes a summary table that sets out a number of trust circumstances and how these circumstances might impact on the exercise of the Commissioner's discretion.
Reasons why someone may want to have a fixed trust entitlement
Classification as a fixed trust under the Commissioner's discretion can provide preferential tax treatment under a number of areas of the taxation legislation. The more common areas the discretion can affect include:
- the ability to pass on franking credits to unitholders;
- the ability for a trust to carry forward tax losses;
- ease of deductibility of borrowings; and
- the application of CGT event E4 to distributions by fixed trusts.
Reasons why someone may NOT want to have a fixed trust entitlement
The merits of preferential tax treatment need to be weighed against a decrease in flexibility of the trust's administration and the corresponding reduction in the trustee's powers. Readers should carefully consider the following examples of restrictions that might be placed on a unit trust that is fixed or has the characteristics of a fixed trust:
- The trustee has no discretion about whether to accept or refuse a unit holder's request for their units to be redeemed. A typical unit trust deed provides the trustee with a discretion to refuse a redemption request. This is so the trustee is not forced to liquidate trust assets to fund the redemption of units. Such a liquidation could adversely affect the interests of other unit holders and could ultimately force the trust assets to be liquidated, or the trust to be wound up.
- The trustee may not refuse to register a transfer of units. A typical unit trust deed provides a trustee with a discretion to refuse a transfer of units. This is so the interests of non-transferring unit holders are not adversely affected by one unit holder's desire to transfer their units, possibly to a unit holder who the non-transferring unit holders do not want to be associated with, or at a price which may devalue the non-transferring units.
- The trustee may need to seek unit holder agreement before accumulating any income of the trust. A typical unit trust deed provides the trustee with a discretion to retain trust income, including because the trustee wants some cash reserves available for future contingencies. If the trustee wants to retain this discretion, then it would not want to have to obtain the written agreement of the unit holders to accumulate income, even though such a requirement would be consistent with the unit holders having a present entitlement to the income of the trust.
- The trustee may be restricted from varying certain clauses of the trust. A fixed trust may limit how the trustee can vary the trust deed. However, there may be circumstances where the trustee determines that the trust's proper administration or pursuit of the trust's aims calls for the variation of the trust deed.
Consider the aims and needs of your trust
For more information on whether your trust is or should be fixed, or for general structuring information, contact Maddocks on (03) 9258 3555 and ask to speak to a member of the Commercial team or the Revenue team.
More Cleardocs information on related topics
You can read earlier ClearLaw articles on a range of topics.
Order Cleardocs trust packages
- Unit Trust — fixed
- Unit Trust — non-fixed
- Discretionary (Family) Trust
- Change of Trustee Unit Trust
- Change of Trustee Discretionary Trust
- Hybrid Trust
- Service Agreement
 Section 272-5(3) of Schedule 2F of the ITAA36.